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Islamic finance 2.0, regulation 1.0
Trading in Shariah-compliant products is about to enter a new age. But as the controversy over the Nakheel sukuk illustrated, the industry is still mired by a lack of transparency.
February 16, 2010 9:22 by Ben Flanagan
When Dubai’s troubled state-owned conglomerate Dubai World announced a debt standstill last November, it threw the global markets into turmoil. It also threw Islamic finance into turmoil, given that a $4.1 billion sukuk linked to Dubai World subsidiary Nakheel – reported to be the world’s biggest-ever Islamic bond – was due for repayment in December.
Following a last minute bailout by Abu Dhabi, the Nakheel bond was paid. But knowledge that the sukuk – one apparently backed by some not-so tangible assets – was so close to defaulting, threw doubt over the assumption that Islamic finance is ‘low risk’.
One lesson of the Nakheel drama is that sukuk investors do not necessarily have access to the ‘tangible’ assets. Farmida Bi, a partner at Norton Rose, yesterday told the Reuters Islamic Banking and Finance Summit in London that investors had failed to understand where their recourse lies in the event of a default. “Many don’t seem to have done their homework – some of them thought they had recourse to the underlying asset and they don’t,” she said. “It seems to be a sort of willful blindness.”
Another issue is that there is some “wishful thinking around implied [sovereign] guarantees”, says Bi: “No one has worked out how [the secular and Shariah legal systems] interact – it remains an untested legal system.”
Some deny that Nakheel’s struggle to repay the $4.1 billion bond is linked to any special risks attached to Islamic banking. Tirad Mahmoud, CEO of Abu Dhabi Islamic Bank, recently told Bloomberg that the near-default was not down to any extraordinary weakness in the Islamic structure. “Maybe people thought if it is Islamic, it is zero risk. But Islamic banks never promise guaranteed outcomes,” said Mahmoud.